Deep Learning and the Cross-Section of Expected Returns

Deep learning is an active area of research in machine learning. I train deep feedforward neural networks (DFN) based on a set of 68 firm characteristics (FC) to predict the US cross-section of stock returns. After applying a network optimization strategy, I find that DFN long-short portfolios can generate attractive risk-adjusted returns compared to a linear benchmark. These findings underscore the importance of non-linear relationships among FC and expected returns.
The results are robust to size, weighting schemes and portfolio cutoff points. Moreover, I show that price related FC, namely, short-term reversal and the twelve-months momentum, are among the main drivers of the return predictions. The majority of FC play a minor role in the variation of these predictions.